Steve Cordasco and David Evanson

TheStreet.com, Winter, 2013

Sometimes historians refer to the period between World War I and World War II as “the long weekend.” Flaws in the Treaty of Versailles enabled Germany to re-arm amid the turmoil of the times, eventually leading to a repeat of the global conflagration.

Regrettably, we find ourselves in a long weekend now, having lived through the war over the fiscal cliff, we now face the prospect of an equally disruptive spasm over the debt ceiling.

Brace yourself.

The issues of taxes and spending are vital to an economy and investors as we move into a new year. The country has been borrowing from a future economy to pay for todayzzs. That policy, along with very low to non-existent interest rates, has helped support corporate profits at record levels.

For the first time in memory we have a Federal Reserve stating that higher stock prices are a policy tool although nothing in its charter grants that organization such authority.

In turn, we have politicians looking at the markets for clues as to the effects of policy. So policy is somewhat dictated by market behavior that is somewhat dependent on various forms of intervention. This is not the market of our youth.

As we wait for the coming war on the debt ceiling, we see an economy barely above stall speed. The growth industries appear to governments: local, state and federal. Many have the kind of numbers we would like to see among the stocks in our portfolios. In our lifetimes we have always relied on government to step in with stimulus programs when the private sector swoons.

The problem today is that government is swooning as well. The stimulus efforts havenzzt helped much and I would argue that they may have retarded the economyzzs natural healing processes.

Meanwhile, indexes that measure the true health of the economy have generally illustrated weakening momentum. Industrial production has improved following the hurricane in the northeast but remains below last spring. We see the same thing in real (after inflation) retail sales and wages.

Worse, we see similar problems in much of the developed world. Our collective economies seem to be an invitation to central banks to print money as they attempt to float their economies on a sea of credit. The longer-term consequences for consumer prices are less important than the diminishing cost of government liabilities. Inflation reduces the real value of debts and makes them easier to repay.

Even modest inflation of 3% will reduce the real (after inflation) value of money by half in 24 years. So governments borrow money to fund promises made by elected officials while unelected central bankers try to inflate away the value of the debt incurred. Itzzs collective irresponsibility.

With interest rates below the rate of inflation the affluent are faced with the prospect of wealth diminishment through inflation or taking investment risks that are uncomfortable for many. Whether we raise the debt ceiling is somewhat less relevant to the larger issue of money being created rather than earned to fund the promises of this generation.

We start the new year cautiously earning cash flow from investments we believe prudent for the environment we see. Money is not made or protected by being optimistic or pessimistic. It is made and protected by planning and strategy so the country can go to war over the debt ceiling without you being made a refugee.